Tutorial III – Working Capital Management
SHORT-TERM FINANCE AND PLANNING
1. The operating cycle is the inventory period plus the receivables period.
Inventory turnover = COGS / Average inventory
Inventory turnover = $165,763 / [($17,385 + 19,108) / 2] = 9.0846 times
Inventory period = 365 days / Inventory turnover
Inventory period = 365 days / 9.0846 = 40.18 days
Receivables turnover = Credit sales / Average receivables
Receivables turnover = $216,384 / [($13,182 + 13,973) / 2] = 15.9370 times
Receivables period = 365 days / Receivables turnover
Receivables period = 365 days / 15.9370 = 22.90 days
So, the Operating cycle = 40.18 days + 22.90 days = 63.08 days
The cash cycle is the operating cycle minus the payables period.
Payables turnover = COGS / Average payables
Payables turnover = $165,763 / [($15,385 + 16,676) / 2] = 10.3405 times
Payables period = 365 days / Payables turnover
Payables period = 365 days / 10.3405 = 35.30 days
Cash cycle = 63.08 days – 35.30 days = 27.78 days
The firm is receiving cash on average 27.78 days after it pays its bills.
2. Since the payables period is 60 days, the payables in each period will be:
Payables each period = 2/3 of last quarter’s orders + 1/3 of this quarter’s orders
Payables each period = 2/3(.75) times current sales + 1/3(.75) next period sales
Q1 Q2 Q3 Q4
$1,137.5 $1,220.0 $1,080.0 $1,051.2
Payment of accounts 0 0 0 5
Wages, taxes, other
expenses 287.00 336.00 304.00 256.00
Interest and Dividens 73.00 73.00 73.00 73.00
$1,497.5 $1,629.0 $1,457.0 $1,380.2
Total 0 0 0 5
3. The sales collections each month will be:
Sales collections = .35(current month sales) + .60(previous month sales)
Given this collection, the cash budget will be:
April May June
Beginning cash balance $443,500 $394,227 $503,450
Cash receipts
Cash collections from credit
sales 410,249 580,695 619,207
Total cash available 853,749 974,922 1,122,657
Cash disbursements
Purchases 247,100 232,850 277,900
Wages, taxes, and expenses 62,964 76,364 79,670
Interest 18,058 18,058 18,058
Equipment purchases 131,400 144,200 0
Total cash disbursements 459,522 471,472 375,628
Ending cash balance $394,227 $503,450 $747,029
CREDIT AND INVENTORY MANAGEMENT
4. The interest rate for the term of the discount is:
Interest rate = .01/.99 = 1.01%
And the interest is for: 30 – 10 = 20 days
So, using the EAR equation, the effective annual interest rate is:
EAR = (1 + Periodic rate)m – 1
EAR = (1.0101)365/20 – 1 = 20.13%
a. The periodic interest rate is:
Interest rate = .02/.98 = 2.04%
EAR = (1.0204)365/20 – 1 = 44.59%
b. EAR = (1.0101)365/50 – 1 = 7.61%
c. EAR = (1.0101)365/15 – 1 = .2771, or 27.71%
5. The average collection period is the net credit terms plus the days overdue, so:
Average collection period = 30 + 5 = 35 days
The receivables turnover is 365 divided by the average collection period, so:
Receivables turnover = 365/35 = 10.4286 times
And the average receivables are the credit sales divided by the receivables
turnover so:
Average receivables = $8,950,000 / 10.4286 = $858,219.18
6. The cash flow from either policy is:
Cash flow = (P – v)Q
So, the cash flows from the old policy are:
Cash flow from old policy = ($104 – 47)(2,870) = $163,590
And the cash flow from the new policy would be:
Cash flow from new policy = ($108 – 47)(2,915) = $177,815
So, the incremental cash flow would be:
Incremental cash flow = $177,815 – 163,590 = $14,225
The incremental cash flow is a perpetuity. The cost of initiating the new policy
is:
Cost of new policy = –[PQ + v(Q – Q)]
So, the NPV of the decision to change credit policies is:
NPV = –[($104)(2,870) + ($47)(2,915 – 2,870)] + $14,225/.025 = $268,405
7. If the cost of subscribing to the credit agency is less than the savings from
collection of the bad debts, the company should subscribe. The cost of the
subscription is:
Cost of the subscription = $950 + $15(700) = $11,450
And the savings from having no bad debts will be:
Savings from not selling to bad credit risks = ($650)(700)(.04)
Savings from not selling to bad credit risks = $18,200
So, the company’s net savings will be:
Net savings = $18,200 – 11,450 = $6,750
The company should subscribe to the credit agency.